The Gold-Oil Ratio

The Link Between Gold and Oil

Gold and crude oil prices tend to rise and fall in sympathy with one another.
There are two reasons for this:

Historically, oil purchases were paid for in gold. Even today, a sizable
percentage of oil revenue ends up invested in gold. As oil prices rise, much
of the increased revenue is invested as it is surplus to current needs --
and much of this surplus is invested in gold or other hard assets.

Rising oil prices place upward pressure on inflation. This enhances the
appeal of gold because it acts as an inflation hedge.

Gold Price History

The chart below starts with the Yom Kippur war between Israel and its
neighbors in 1973 -- and the resulting Arab oil embargo when crude oil rocketed
from $3 to $12/barrel. This was followed by the 1978 revolution in Iran and the
Iran-Iraq war in 1980 which lasted until 1988. Iraq then invaded Kuwait in 1990,
but the ensuing Gulf War had a limited effect on gold prices.

Gold went into a decline until awakened from its slumber on September 11,
2001. The invasion of Iraq followed in 2003, initiating a strong up-trend, and
prices have lately spurred even higher as tensions escalate over Iran's nuclear
program.

Oil Price History

Yom Kippur started a huge spike in oil prices with the Arab oil embargo in
1973. This was followed by another spike in 1978 at the time of the Iranian revolution,
culminating with the subsequent invasion by Iraq and the start of the Iraq-Iran
war. The Saudis substantially increased production in 1985 and the Iraq-Iran ceasefire
further eased shortages in 1988. The invasion of Kuwait and ensuing
Gulf war caused a brief spike in 1990, but a relatively stable period then followed -- until
1998 when OPEC increased production while demand was falling due to the Asian
financial crisis, causing a slump in prices. Subsequent production cuts saw
price recover, before September 11 and the 2003 invasion of Iraq heightened
fears of further shortages.

The gold-oil ratio helps us to identify overbought and oversold opportunities for
gold. The chart below shows solid support between 8 and 10 barrels/ounce of gold over
the last 30 years, with occasional spikes carrying above 20 but seldom
holding for any length of time.